Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the virtual money Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2010 inclusively) provides a CAGR of around 13.8%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.4%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance. The “cash” line for the “Cost” column is negative because the total cost of the securities presently in the fund exceeds the starting value of the fund by $7,000 (as profits from the sales of previously held positions have been reinvested; this is a good thing). Finally, the “cash” line for the “Value” column is reduced each quarter by a management fee (annual rate of 1% of the principal under management). More information about how the IMSIP is managed can be found here.

Transactions: Finally a quarter with some action! (After only two transactions in the previous six months.) Uncharacteristically, we even bought, sold (at a profit), and then bought back (at a lower price) the same equity—the Russell 2000 short ETF (RWM)—as the odds of a short-term catastrophic collapse in Europe appeared to gyrate notably.

Performance Review: A very tough quarter. We were down 7.1%, our third-worst quarter ever (out of 19). And while we avoided the fate of the S&P 500—which was down a bear-market-and-a-half at -14.3% for the quarter—the second-worst performance in the last 19 quarters—we spectacularly failed to keep pace with the macro hedge fund index (+2.0% for the quarter). Generally, most macro hedge funds were shorter sooner than us, with less exposure to emerging market long funds than we had this quarter. And indeed, our BRIC funds continued to plunge, with Brasil (EWZ) down 27%, China (FXI) down 26%, and India (IFN) down 14%. Precious metals weren’t much help: gold (GLD) was up 9% but silver (SLV) was down 15%. Caught in the middle, our small miner ETF (GDX) was up 1%. Our other commodity investment, agriculture products (DBA), was down 6%. Our short funds helped tad—the S&P 500 short fund (SH) was up 4% overall, the Russell 2000 short fund (RWM) was up 8% overall, and the banking/finance short fund (SEF) was up 1%. We probably should have been shorter, sooner.

Our transactions were a bright spot. We sold RSX, SH, RWM, and UDN all at a modest profit. We ended the quarter having reentered the SH (at a higher price) and RWM (at a lower price) positions; RSX closed on 30 Sep down 34% from where we sold it, so that was one bullet dodged. UDN was down 2% from where we sold it by the end of the quarter.

Overall we are now 39 points ahead of the market in terms of total return-on-investment: +19% for us and -20% for the S&P 500 in the 57 months since the inception of the IMSIP at the end of 2006. However, we are now behind our benchmark, the GAI Global Macro Hedge Fund Index, which is +28%. In terms of compounded annual growth rate, after just shy of five years the GAI hedgies are at +5.4%, IMSIP is +3.7%, and the S&P 500 is -4.7%.

There were some changes in the composition of the the portfolio’s composition this quarter. We are now 43% invested in commodities, up from 36% and 29% short, up from 17%, reflecting the addition of the Russell 2000 index short ETF (RWM) and financials short ETF (SEF) to the lineup, offset by the loss of the U.S. dollar short fund (UDN). Our BRICs investments are down to 22% from 36%, reflecting both the sale of our Russian ETF and the overall decline in valuation for the other BRIC ETFs. Despite all the transactions, our cash position ended the quarter pretty nearly the same: 5% of the port up from 4% at the end of 2Q11.

Business Insider: Bill Gross says this debt deal does nothing, and we still have an “unfathomable” $66 Trillion in liabilities to cope with http://read.bi/rkG5Ei

Business Insider:Doug Kass outlines the four potential outcomes of our ailing economy read.bi/pGwHce

Analysis: A relatively large portion of excrement hit the rotary air recirculation device this quarter, but in our view, sorry to say, we ain’t seen nuttin’ yet.

The overall risk of systemic failure—for which we feel the market has not adequately accounted—is clearly elevated here. While the problems associated with the housing bubble collapse of 2007-08 linger—zombie banks stuffed toxic assets mis-valued thanks to the connivance of regulators so as to maintain the pretense of solvency, millions of homeowners “under water” owing more on their mortgages than the market value of their property, continuing bailout distributions of taxpayer wealth mostly in the form of sweetheart below-market interest loans, no meaningful reform of the derivatives market, no serious attempt to address the Federal budget deficit (as we expected, the August debt limit raise deal constituted another inconsequential “pay-you-Tuesday-for-a-hamburger-today/kick-the-can-down-the-road” maneuver)—we now have the added pressure of multiple sovereign debt crises in Europe. The specter of default has caused interest rates on bond offerings by Greece and Italy to surge to levels so high as to call into question those countries’ ability to service their debt. A default would be doubly dangerous because [a] while most bondholders have purchased credit default swap (CDS) insurance on their bond holdings, no one knows if the unregulated CDS equities will or can be honored by the issuers in the event of a default—and if they are not honored, many weaker banks (not just in Europe) may not be capable of absorbing the consequent bond losses—and [b] once any one Eurozone country defaults, all the others will be considered more risky and borrowing costs will go up.

Our best bet is that The Powers That Be (TPTB) will ultimately cobble together yet one more saving throw to stave off the crash for another year or so. They can probably get some mileage out of a mechanism whereby the European Central Bank—either directly or indirectly through another entity—steps forward as the lender-of-last-resort (LOLR) for Greece-Italy-Spain-et al, printing Euros as needed to fund bond purchases. The problem with this solution is that printing Euros out of thin air would be inflationary and is opposed by Germany, the strongest country in the Eurozone. Oh, yeah and also that it is essentially fighting fire (too much debt) with gasoline (affording the deadbeat still more credit)…not a viable long-term solution.

And while concerns about the European sovereign debt crisis are now paramount, we have the looming U.S. Super Committee debt reduction plan deadline (next month)—there could be another credit rating downgrade if a serious plan is not agreed to but that is a long shot prospect at best now that the 2012 election cycle is well underway. Plus the continuing unrest in the Arab world—currently most worrisomely, Syria—the threat of a double-dip recession in the USA, an apparent slowdown in China along with continued concern about their real estate bubble and weak banks with bad loans outstanding, or any number of other potential “black swans.”

Conclusion: What has to happen really isn’t all that complicated: there is a whole mess of bad—we would say, “fraudulent”—debt out there that has to be forgiven. The problem is that admitting that all those mortgages and related securities (in the USA) and sovereign debt (in the Eurozone) are worthless would tank most of the major banks, disenfranchise a lot of very wealthy (in theory) and very powerful (in practice) individuals, and cause a major economic disruption whilst we rebooted our financial system…most probably with some safeguards and limitations that TPTB are loathe to contemplate, and in any event with few of those miscreants ending up back in charge of anything important.

So, since 2008 the USA has harbored numerous “zombie” banks that are essentially insolvent but allowed by captive regulators to continue to operate, using various and sundry accounting gimmicks—most prominently, the hamstringing of the mark-to-market rule—to disguise their discorporation. And now, we are seeing similar entities tolerated in the Eurozone…only these are not just banks, but entire nations.

In theory, the justification for this strategy of “extend-and-pretend” is that [a] an honest but sudden writedown of the toxic bad debt assets would be too disruptive and [b] if we kick the can down the road long enough, it will give us time to kick-start economic growth again which will both increase the value of some of the marginal assets and enable us to liquidate the hopeless ones more gradually.

Well, there is no denying that a liquidation of the zombie banks back in 2008 would have been very disruptive. And if we bit the bullet now, it would be worse, seeing as we are three years deeper in debt and the ranks of the unemployed have swollen in the interim…and the longer we wait, the bigger the size of the hole we will have to climb out of, and the weaker we will be for the effort required. Because the notion that we can kick-start growth and somehow reach a better place without clearing out the bad debt sludge is utter fantasy…there is no light at the end of this tunnel TPTB have us marching through…just a deeper, hotter pit.

For the time being, we continue to hold long emerging market ETFs for three of the four BRIC nations in the portfolio: Brasil (EWX), India (IFN), and China (FXI) (having liquidated our position in Russia, as mentioned above). The higher risk attendant to the Eurozone crisis has made these investments more risky, partly because the danger of a collapse is greater and partly because the threat to the Euro has perversely strengthened the dollar, and exacerbated a decline in the relative valuations of BRICs assets. Never-the-less, we are not prepared to go totally short because we believe TPTB can still stave off disaster for a spell by some variation of the Quantitative Easing maneuver the central banks pulled after 2008 in order to constitute a well-heeled LOLR for the zombie countries (the PIIGS plus whoever else needs it). Of course, in the long run, loaning more money to deadbeats is not a winning formula, but in the short run, it would have an inflationary effect which coupled with the euphoria that disaster has apparently been averted again could drive a significant market rally. If this happens, we will likely repurchase our Russia position (which is a lot cheaper now than when we sold it).

We also retain our four long commodity plays: the agriculture ETF (DBA), the precious metals ETFs for gold (GLD) and silver (SLV), and the mining ETF (GDX). Commodities remain relatively more attractive stores of value (although as the mining ETF is only a proxy for commodities and the short- and medium-term outlooks are so uncertain for companies, we may cash out those funds and redeploy them into a purer commodity play). Most definitely, if you don’t have some of your own wealth allocated to precious metals, you should reconsider.

We now have three short positions, although—as reported above—we dropped our dollar short ETF when the Euro started seriously tanking. We are still short the S&P 500 index (SH), and have added a banking sector short ETF (SEF) as well as a Russell 2000 short ETF (RWM) as insurance against a black swan event such as a near-term default.

The investing weather remains very turbulent. In times of heightened uncertainty, valuations can fluctuate wildly and the preservation of capital takes precedence over meeting any target ROI. In the long run, these problems will get worked out and on the other side there will be great growth opportunities. In the medium term, things look black and we probably need to be totally short. In the short term, the future, as they say, is cloudy. Stay tuned.

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the virtual money Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2010 inclusively) provides a CAGR of around 13.8%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.4%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance. The “cash” line for the “Cost” column is negative because the total cost of the securities presently in the fund exceeds the starting value of the fund by $7,000 (as profits from the sales of previously held positions have been reinvested; this is a good thing). Finally, the “cash” line for the “Value” column is reduced each quarter by a management fee (annual rate of 1% of the principal under management). More information about how the IMSIP is managed can be found here.

Performance Review: Not much worked right for us in the second quarter. We were down 4.7%, effectively wiping out our 1Q11 gains, and we lost to both the S&P 500 index (down 0.4%), and the macro hedge fund index (down 0.9%). Our BRIC funds were unanimously negative, with Russia (RSX) down 7%, India (IFN) down 5%, Brazil (EWZ) down 4%, and China (FXI) down 3%. Precious metals weren’t much better: gold (GLD) was up 4%, but the miner ETF (GDX) was down 13% and silver (SLV) was down 8%. Our other commodity investment, agriculture products (DBA), was down 7%. Our short funds were a wash with the U.S. dollar short ETF (UDN), +4% and the S&P 500 short fund -4%.

Overall we are now 35 points ahead of the market in terms of total return-on-investment: +28% for us and -7% for the S&P 500 in the 54 months since the inception of the IMSIP at the end of 2006. We are slightly ahead of our benchmark, the GAI Global Macro Hedge Fund Index, which is +25%. In terms of compounded annual growth rate, after four-plus years IMSIP is +5.6%, the GAI hedgies are at +5.1%, and the S&P 500 is -1.6%.

There were some changes in the composition of the the portfolio’s composition this quarter. We are now 36% invested in commodities, up from 33%—reflecting the addition of the miner ETF (GDX) offset partially by an overall decline in the value of our commodity positions—and 17% short, up from 8%, reflecting the addition of the S&P 500 index short ETF (SH) to the lineup. Our cash position is down from 22% of the port to 4%, reflecting the cost of adding these two new positions. The 36% investment in emerging markets remained stable.

Charles Hugh Smith: The Death of Demand—The Post-Consumer Debt Economy…Dark Side of Keynesian Debt goo.gl/KwVUM

Analysis: The market closed nearly flat in 2Q11, but that masks a notable intra-quarter decline as it appeared likely that Greece would default, and the subsequent recovery almost back to even when Eurozone authorities came up with yet another rescue plan and the Greek government implemented putatively stronger austerity measures.

In the long term, we remain concerned about the overall risk of systemic failure, for which we feel the market has not adequately accounted. We got into this situation by overspending, borrowing beyond our means, and speculating on bubble-valued assets. And the policies the Bush administration implemented—and the Obama administration has continued—of attempting to paper over the cracks in the system with bailouts of bad banks, bad real estate loans, bad credit default swaps, and bad industrial companies are neither the morally correct thing to do nor in our own long-term self interest. While these actions can be effective in postponing our day of reckoning—indeed, the “QE2” $600B round of quantitative easing by the Fed has clearly succeeding in kicking the can further down the road—they ultimately succeed primarily in digging us into a deeper hole.

For the medium term, however, massive injections of liquidity and restrictive interest rate policies that artificially deflate the return on investment of “safe” savings accounts and short-term bonds have pushed investment funds into the stock market, floating it higher. Combined with the exigencies of the USA election cycle which incentivizes government and government supporters to make an extra effort to gussie up our own pig—e.g., release crude oil from the strategic reserve to ensure that gasoline prices moderate going into the 2012 election—it is reasonably likely that a meltdown can be averted for up to another 18 months. However, we do not expect the “good news” concerning economic recovery to survive the reduction in government stimulus concomitant with the end of the QE2 program last month and remain prepared to move to a short bias to preserve capital if bad economic data tank the market. And while concerns about the European sovereign debt crisis have abated for now with the latest Greece rescue, the Euro PIIGS (Portugal-Ireland-Italy-Greece-Spain), could ensue squealing again at any moment. Plus we have the looming U.S. debt limit deadline (2 August according to the latest official announcement although the real date is probably later), the continuing unrest in the Arab world, serious municipal bond defaults or a defaults-driven residential real estate crisis in the USA, a slowdown in China, or any number of other potential “black swans.”

Conclusion: Although we doubled our short exposure this quarter from 8% to 17% of the portfolio, we are still reasonably optimistic that in the medium term, the-powers-that-be will pull out all the stops to continue to sell the fiction that all is well and the economy is slowly but steadily recovering from the 2008 shock. On this side of the pond, just as the banksters and their political trained seals hoodwinked and bullied us into bailing out the “too big to fail” institutions in 2008 with their predictions of Armageddon, we expect a repeat performance this time around. At the end of the day, we will probably end up with perhaps two trillion dollars or so reduction of the $14+ trillion debt spread out over the next decade that will enable everyone to say that they extracted a pound of flesh but in the end will not seriously impact military spending or entitlements…nor effectively address our long-term problems. In Europe, we eventually expect that the bad Greek paper will be called in and replaced with (much) longer-term bonds for the same face value. A scheme such as this should enable the banks and credit rating agencies to maintain the pretense that all is copacetic while providing Greece with a light at the end of the tunnel. These dual “extend-and-pretend” approaches to our economic problems will not serve indefinitely. But predicting exactly when the fecal matter will hit the air accelerator mechanism is akin to predicting when a coin flipped once every minute that has come up “heads” ten time running will finally show “tails”…one expects it any minute now, but is quite probable it might not happen yet for several minutes…and theoretically possible it will never happen, although that is a virtual impossibility.

In the event, we continue to hold long emerging market ETFs for all four BRIC nations in the portfolio: Brasil (EWX), Russia (RSX), India (IFN), and China (FXI). We believe that in a deleveraging environment, the economies that are still growing relatively strongly will fare better than those that are not and we expect non-dollar-denominated assets to do better than those tied to the greenback. Never-the-less, when things get really dicey, those nations’ economies will suffer also—the Russian RSX ETF declined 70% in the wake of the 2008 crisis—and we will not want to be long any of these when the winds of chaos pick up again.

We now have four long commodity plays: the agriculture ETF (DBA), the precious metals ETFs for gold (GLD) and silver (SLV), and the mining ETF (GDX). With the dollar, the Euro, and the Yen all under pressure here for various and sundry reasons, any currency is risky at best, and thus commodities are relatively more attractive stores of value. If you don’t have some of your own wealth allocated to precious metals, you should reconsider.

We now also have two short positions. We continue to be short the dollar (UDN), which at this point appears to be a no-brainer, and we are also short the S&P 500 index (SH) as a hedge against a black swan event such as a near-term default.

Although we are remain biased toward the long positions now, we remain vigilant as to a potential turning of the tide. In times of heightened uncertainty, valuations can fluctuate wildly and the preservation of capital takes precedence over meeting any target ROI. To that end, when the phantasmic prospect of sustained economic growth sans serious deleveraging fades—that is, when the Kool-Aid runs out—we will be prepared to unload our long positions, possibly excepting the commodities, and increase our exposure to index shorts again. However, we remain wary that, with another election cycle approaching, the U.S. government is likely to attempt to maintain low interest rates and resume big-time quantitative easing at the first unconcealable sign of a “downturn.” The recent surprise release of oil from the Strategic Petroleum Reserve—referenced above—is evidence of The Powers That Be’s willingness to pull out all the stops to maintain the fiction that the 2008 bailout is working. So long as these policies succeed in weakening the dollar and pushing up nominal equity valuations, it will be too early to go completely short. Stay tuned.

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the virtual money Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2010 inclusively) provides a CAGR of around 13.8%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.4%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance. Finally, the “cash” line for the “Cost” column is reduced each quarter by a management fee (annual rate of 1% of the principal under management). More information about how the IMSIP is managed can be found here.

Transactions: After all that action at the end of 2010, we had an extremely quiet quarter: no transactions whatsoever for the first time since 2009.

Performance Review: Yet another modest gain which—for the third consecutive quarter—failed to keep pace with the market. We were up 4.8%, which normally is good, but we still narrowly lost to the S&P 500 index (+5.4%). We did handily outdistance the macro hedge fund index (-0.6%), primarily because most macro funds have maintained more short positions than we have.

The star performer of the quarter was silver (SLV), up 22%, way outdistancing our other commodity plays, including our corn-wheat-soybeans-sugar ETF (DBA, up 6%) and gold (GLD up 1%). On a semi-related note, our one remaining short position is the U.S. dollar (UDN, +4% as the decline in the dollar of the value continued). Our BRIC funds were mixed, with Russia (RSX) up 10%, China (FXI) up 4%, Brazil (EWZ) flat, and India (IFN) down 4%.

Overall we are now 41 points ahead of the market in terms of total return-on-investment: +34% for us and -7% for the S&P 500 in the 51 months since the inception of the IMSIP at the end of 2006. We are slightly ahead of our benchmark, the GAI Global Macro Hedge Fund Index, which is +26%. In terms of compounded annual growth rate, after four-plus years IMSIP is +7.2%, the GAI hedgies are at +5.6%, and the S&P 500 is -1.6%.

Analysis: Well, unsurprisingly given that we had no transactions changing any of our positions, the portfolio’s composition—36% emerging markets, 33% commodities, 8% short the dollar, and 22% cash—is not much changed from last quarter…we have proportionately less cash and more invested in commodities, but that is mostly attributable to the +22% burst in silver prices.

So, what’s going on with silver? Well, back when silver and gold were commonly used as money, the ratio of their values tended to be about 15:1 (that is, the value of 15 ounces of silver was equivalent to the value of one ounce of gold). But as fiat money became predominant in the 19th and especially the 20th centuries, the ratio has widened and the average in the 1900s was closer to 50:1, and for most of the first ten years of this century, 60:1. Essentially, silver—which, of course, is much more common than gold—lost currency (if you will pardon the expression) as a store of value, and was priced based on demand for industrial use (which has declined in recent decades with the near-death of analog photography as mucho silver was consumed in the development process). But with the financial crisis that started with banks in 2008 morphing to sovereign debt in 2010, fiat currencies are looking shaky, and silver is making a strong comeback, spurred on by the existence—or, at least, rumors of the existence—of a large short position which presumably will have to be covered if prices continue to rise. Check out this chart of the silver:gold ratio since the inception of the IMSIP:

Overall, the market continued bullish in 1Q10. We remain concerned about the overall risk of systemic failure, for which we feel the market has not adequately accounted. We got into this situation by overspending, borrowing beyond our means, and speculating on bubble-valued assets. And the policies the Bush administration implemented—and the Obama administration has continued—of attempting to paper over the cracks in the system with bailouts of bad banks, bad real estate loans, bad credit default swaps, and bad industrial companies are neither the morally correct thing to do nor in our own long-term self interest. While these actions can be effective in postponing our day of reckoning—indeed, the “QE2” $600B round of quantitative easing by the Fed has clearly succeeding in kicking the can further down the road—they ultimately result primarily in digging us into a deeper hole. For now, massive injections of liquidity and restrictive interest rate policies that artificially deflate the return on investment of “safe” savings accounts and short-term bonds have pushed investment funds into the stock market, floating it higher, but we do not expect the “good news” concerning economic recovery to survive the pending reduction in government stimulus when the QE2 program ends in June and remain prepared to move to a short bias when that happens to preserve capital. And it could happen sooner if the wheels come off with respect to the European sovereign debt crisis, the continuing unrest in the Arab world, serious municipal bond defaults or a defaults-driven residential real estate crisis in the USA, a slowdown in China, or any number of other potential “black swans.” In the meantime, however, we are swimming with the tide and remain long.

Conclusion: We remain in the eye of the storm with most everyone sipping the QE2 Kool-Aid and singing Kum-Ba-Ya. Accordingly, it is time to make love, not war…but we remain prepared for both.

We hold long emerging market ETFs for all four BRIC nations in the portfolio: Brasil (EWX), Russia (RSX), India (IFN), and China (FXI). We believe that in a deleveraging environment, the economies that are still growing strongly will fare better than those that are not and we expect non-dollar-denominated assets to do better than those tied to the greenback. Never-the-less, when things get really dicey, those nations’ economies will suffer also—the Russian RSX ETF declined 70% in the wake of the 2008 crisis and we will not want to be long any of these when the winds of chaos pick up again.

We also still have three long commodity plays: the agriculture ETF (DBA) and precious metals ETFs for gold (GLD) and silver (SLV). With the dollar, the Euro, and the Yen all under pressure here for various and sundry reasons, any currency is risky at best, and thus commodities are relatively more attractive stores of value. And we are actually short the dollar (UDN), although it has held up remarkably well in the face of the USA’s deteriorating monetary and fiscal situation, thanks presumably to the relative unattractiveness of the other major currencies…except the Yuan, but the Chinese government restricts it’s appreciation.

Although we are mostly long now in congruence with the prevailing love fest, we remain vigilant as to a potential turning of the tide. In times of heightened uncertainty, valuations can fluctuate wildly and the preservation of capital takes precedence over meeting any target ROI. To that end, when the phantasmic prospect of sustained economic growth sans serious deleveraging fades—that is, when the Kool-Aid runs out—we will be prepared to unload our long positions, possibly excepting the commodities, and short the indices again. However, we also cognizant of the prospect that, with another election cycle approaching, the U.S. government is likely to attempt to maintain low interest rates and resume big-time quantitative easing at the first unconcealable sign of a “downturn.” So long as that combination of policies conspires to weaken the dollar and push up nominal equity valuations, it will be too early to go short. Stay tuned.

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the virtual money Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2010 inclusively) provides a CAGR of around 13.8%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.4%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance. Finally, the “cash” line for the “Cost” column is reduced each quarter by a management fee (annual rate of 1% of the principal under management). More information about how the IMSIP is managed can be found here.

Transactions: OK, so much for the theory that less volatility invariably begets fewer transactions…when you are positioned for a potential apocalypse and instead everyone drinks the Fed’s Kool-Aid and starts singing kum-ba-ya, some significant maneuvers are called for.

Performance Review: Another modest gain which—for the second consecutive quarter—failed to keep pace with the market. We were up 5%, which normally is good, but we lost to the S&P 500 index (+10%) by five points. We did beat the macro hedge fund index (+3%) by two points.

Tactically, we ditched our index shorts for losses in November in the face of a second round of quantitative easing from the Fed. This $600 billion flood of money may not do much to heal the economy—in our view, it hurts us by propping up zombie too-big-to-fail financial institutions whose existence exacerbates structural problems and impedes recovery—but combined with continued low interest rates it is driving investment funds into the equities markets. Under those circumstances, being short the market may be philosophically appropriate but it sure generates a lot of red ink in a hurry. We also sold our high-grade corporate bond ETF (LQD, for a tiny loss) due to concern that QE2 will result in higher interest rates and took a short position on the dollar (UDN) due to concern QE2 will weaken the greenback.

As the year ended, we added the fourth BRIC component, Russia, to the portfolio for the first time via the Market Vectors Russia ETF (RSX). The other three BRIC ETFs overall were all up in the quarter, though all trailed the market: India (IFN, +8%), Brazil (EWZ, +4%), and China (FXI, +1%). The commodity ETFs outperformed on average, with SLV (silver) the star of the port at +42%, DBA (basket of agricultural commodities) +18%, and GLD (gold) +8%. The three index short ETFs had a tough quarter, of course: DOW (DOG) -11%, NASDAQ (PSQ) -14%, and S&P 500 (SH) -11%. Our newly acquired shot dollar fund (UDN) was down 2% in a month-and-a-half.

For 2010 overall, we trailed both both the macro hedge fund index and the S&P 500 index, +4% for us compared to +8% for the hedgies and +13% for the market. DBA was +24%, IFN +21%, EWZ +4%, and FXI +3% for the year. Although we only held them for part of the year, SLV was +75% for us and GLD was +20%.

We are now 39 points ahead of the market in terms of total return-on-investment: +28.1% for us and -11% for the S&P 500 in the four full years since the inception of the IMSIP at the end of 2006. This puts us just slightly ahead of our benchmark, the GAI Global Macro Hedge Fund Index, which is +26.9%. In terms of compounded annual growth rate, after four years IMSIP is +6.4%, the GAI hedgies are at +6.1%, and the S&P 500 is -3%.

Analysis: Well our portfolio looks a bit different now (36% emerging markets, 31% commodities, 8% short the dollar, and 25% cash) than it did a quarter ago (27% emerging markets, 26% commodities, 9% bonds, 26% short the market, and 12% cash). Three months ago we were 26% short and now we are only 8% short…but that doesn’t mean we think things are looking up.

There is no arguing the fact that one thing is looking up, however: the market. Volatility—how much the market moves up or down—is a good measure of perceived risk: as investors perceive the market as more risky and uncertain and tend to sell, prices fall and volatility generally rises. But volatility has been declining sharply since the 2008 crash—as market values have risen—and in 4Q10, volatility for the S&P 500 fell below the 50-year average for the first time in over three years. Evidently, investors collectively believe that the risk of something bad happening has been reduced.

We demur.

We see giant multi-national banks that are still stuffed with toxic assets and riding for a fall, a USA real estate market with property values that are still overvalued, developed economy consumers who are still underemployed and overleveraged (especially in the USA), fast-growing emerging market economies that are by their very nature vulnerable to bubbles, and material sovereign debt risk. And, unfortunately, regardless of whether we put Republicans or Democrats in control of the government, our political leaders seem invariably intent on treating the symptoms of our illness, avoiding challenges to any entrenched elites, and hoping and praying they can muddle through with no ultimate crisis on their watch…even at the cost of leaving us with fewer resources to deal with our structural problems when we finally run out of effective delaying tactics.

Be that as it may, central banks in general are working in concert to hold down interest rates and expand liquidity in order to “stimulate” the economy. The Fed in particular is dispensing out $600 billion of financial Kool-Aid with their latest quantitative easing scheme (“QE2”), and funds are flowing into equities, driving market prices higher. Between the value distortions foisted on the market by the manipulations of the central banks and the machinations of the high frequency traders constantly threatening us with a flash crash or worse, the investing waters that appear so calm on the surface are actually quite roiled.

Conclusion: We are in the eye of the storm, and most everyone is sipping the QE2 Kool-Aid and singing Kum-Ba-Ya. Accordingly, it is time to make love, not war…but we remain prepared for both.

We now hold all long emerging market ETFs for all four BRIC nations in the portfolio: Brasil (EWX), Russia (RSX), India (IFN), and China (FXI). We believe that in a deleveraging environment, the economies that are still growing will fare far better than those that are not and we expect that non-dollar-denominated assets to do better than those tied to the greenback. Thus these emerging market long positions will be the last we will surrender if and when things get really dicey.

In the face of QE2 and the continued runup in the price of equities, we dumped our index shorts and—out of concern for possibly rising interest rates—our corporate bond fund. So far, the combination of continued slack consumer demand and Eurozone sovereign debt risk has kept the dollar strong, but against the likelihood that its decline will resume and even speedup, we added the short dollar ETF (UDN). We also still have three long commodity plays: the agriculture ETF (DBA) and precious metals ETFs for gold (GLD) and silver (SLV).

Although we are mostly long now in congruence with the prevailing love fest, we remain vigilant as to a potential turning of the tide. In times of heightened uncertainty, valuations can fluctuate wildly and the preservation of capital takes precedence over meeting any target ROI. To that end, when the phantasmic prospect of sustained economic growth sans serious deleveraging fades—that is, when the Kool-Aid runs out—we are prepared to unload our long positions, possibly excepting the precious metal funds, and short the indices again.

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2009 inclusively) provides a CAGR of around 14.0%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.2%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance. Finally, The “cash” line for the “Cost” column is negative because the total cost of the positions the IMSIP presently hold exceeds the total cash we started with—which is, of course, a good thing—and profits from earlier sales have been reinvested into more recently acquired positions.

Transactions: Less volatility this quarter, and fewer transactions…could this be causal relationship? 🙂

Performance Review: Wow, a mirror image quarter! We were up 4%, which normally is good, but we lost to the market (+11%) by seven points. This is an almost perfect reversal of the prior quarter, in which we lost 4% but beat the market (-12%) by eight points. The IMSIP is just a rock of stability, relatively speaking. We did beat the macro hedge fund index (+1%) by three points. Heck, those guys are even more stable than we are—they gained 1% in 2Q10, too.

Tactically, we ended the quarter still pretty neutral, with three BRIC country long ETFs balanced by three index short ETFs, plus three commodity plays including two flight-to-safety/inflation insurance precious metal funds and our agriculture ETF plus our new high grade corporate bonds ETF, which is a bet on the Fed keeping interest rates low. Our BRIC ETFs overall were up—as one would expect in a +11% market: Brazil (EWZ, +23%), India (IFN, +13%), and China (FXI, +9%). The commodity ETFs also did well, with SLV +17%, DBA +16, and GLD +5%. The three index short ETFs had a tough quarter, of course: DOW (DOG) -11%, NASDAQ (PSQ) -14%, and S&P 500 (SH) -11%. Our newly acquired corporate bond fund (LQD) was up 3% in a month-and-a-half. We also made a profit on our sale of the high tech ETF (IYW), and took a loss unloading the treasuries short fund (TBT).

Overall, we are now 46 points ahead of the market in terms of total return-on-investment: +26% for us and -20% for the S&P 500 in the 45 months since the inception of the IMSIP at the end of 2006. We are five points ahead of our benchmark, the GAI Global Macro Hedge Fund Index, +26% to +21%. In terms of compounded annual growth rate, after three years IMSIP is +6%, the GAI hedgies are at +5%, and the S&P 500 is -6%.

Analysis: The fix is in.

We can argue about why this is happening. Some see dark bankster conspiracies aimed purposefully at destroying confidence in national governments and creating chaos in order to facilitate a world-wide takeover by the powerful elite. Some see an inherent flaw in the democratic process that makes it impossible for leaders to engage in long-term thinking, making the system vulnerable to situations where short-term pain is needed to avert long-term catastrophe…because the very design of the system ensures that short-term pain is always avoided at all costs. Some see nothing more remarkable than the inexorable rise and fall of empires at work here.

Leaving aside the theoretical explanations, as a practical matter, it is more and more clear that the central banks in the developed world are hell-bent on fending off the collapse of any “too big to fail” (TBTF) institutions at all costs. All the Sturm und Drang about the financial reform legislation that was supposed to end TBTF, all the jawboning about greedy bankers and unconscionable bonuses, all the expressions of piety with respect to the need for a strong dollar…all fade to insubstantial misdirection beside the solid reality of never-ending bailouts and so-called “quantitative easing.”

It was bad in the 50s and 60s when the USA financed both wars and increasingly expensive social programs via debt and the dollar began to weaken. It was worse in the 70s and 80s when we divorced the dollar from gold entirely, continued to run up debts, and accelerated the process of eschewing production and manufacturing in favor of financial “services” and ever-more arcane ways to manipulate money. In the 90s and the first decade of the 21st century, we engineered asset bubbles in real estate and stocks to inveigle folks to keep accumulating individual debt and eschew savings, even as a combination of irresponsible new entitlements obligations and an aging population worsened the debt situation of the government.

2008 was a watershed. Or, to borrow an analogy from South African finance minister Pravin Gordhan, a waterpipe—a broken one. Not a pipe we could see, because it was behind the wall, but we could hear the water dripping and see the stains on the wall. It was obvious to everyone that the proximate cause of the crash was the debt-funded asset bubbles. We could have chosen to own up to the errors of our ways, punished the guilty, sorted out the mess of the bursting bubbles, and applied our considerable energies to moving forward building a stabler, healthier financial system with safeguards against the abuses that brought us to this pass.

But instead, we chose to reinflate the bubbles! Rather than allowing housing prices to fall to sustainable levels, we bailed out homeowners who owed more than their properties were worth. Rather than allowing banks who had written bad loans to fail, we bailed them out, by artificially lowering interest rates and firing up the printing presses so they could borrow cheaply and reinvest the funds to make a profit and earn their way out of insolvency. Never mind that [a] it won’t work and [b] in trying to make it work we risk igniting a ruinous currency war. In effect, we threw good public money after bad private money, directly increasing the debt and indirectly—by weakening the dollar—reducing the wealth of all citizens (and their children).

Instead of fixing the broken pipe, we replastered the wall and painted over the water stains. The fix is in, not in the sense of repairing the damage, but in the sense that unscrupulous insiders have rigged it—while we are meant to believe that things are getting better, in fact what is happening is that those in the know have bet on the room being flooded, sooner or later. The flood, of course, will not be water. It will be wheelbarrels full of worthless U.S. dollars.

Conclusion: We know that the foolhardy efforts of the central banks to save the corrupt and insolvent financial system are doomed. What we don’t know is how and when that doom will play out. For the past several months, we have been betting that things may fall apart sooner rather than later; hence our commodities and short positions. There are so many potential black swans flitting about—bad real estate loans, bad banks, insolvent local and state governments, sovereign debt, hyperinflation, potential social unrest in China, Iran and their nukes, North Korea and their nukes, Pakistan and their nukes, the threat of a major terrorist attack, a plague, global warming—that one or more could land at any moment.

In our best effort to avoid black swan excrement, as of 1 October, we continue to hold three long emerging market ETFs in the portfolio: China (FXI), India (IFN), and Brasil (EWX). We believe that in a deleveraging environment, the economies that are still growing will fare far better than those that are not; thus these long positions will be the last we will surrender if and when things get really dicey. Already, things are somewhat dicey…enough so that we hold three inverse index ETFs (that go up when whatever they are tied to goes down) to serve as insurance against a sudden worsening of the sovereign debt crisis: the short DOW index ETF (DOG), the short NASDAQ index ETF (PSQ), the short S&P 500 index ETF (SH). We are considering unloading some or all of these shorts because [a] the cost of holding them has risen along with the strong 3Q10 rally in the stock market and [b] our concern about hyperinflation in the face of a likely second round of quantitative easing by the Fed after election day is daunting. As it is, the overall performance of macro funds has been constrained by the prevalence of significant short positions, in concert with the way the macros are pointing but—thanks at least in part to profligate quantitative easing and related shenanigans by the central banks—contrary to the way the markets are behaving.

We also still have three long commodity plays: the agriculture ETF (DBA) and precious metals ETFs for gold (GLD) and silver (SLV). The dollar is weakening again and the waxing of that hyperinflationary scenario has us considering a short play there.

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2009 inclusively) provides a CAGR of around 14.0%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.3%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance.

Transactions: The sudden return of volatility in 2Q10 had us jumping through hoops with not only more transactions than usual but some hard zigging and zagging…but in the end, all profitable (at least the closed trades):

Performance Review: Normally you’d have no difficulty characterizing a 4% loss as a bad quarter, but when you still beat the market (-12%) by eight points, the waters get a bit muddy. We did lose to the hedgies (±0%) by five points. Tactically, reflecting the schizoid market we are close to neutral here, with our three BRIC country funds plus our high tech fund bullish, our four short funds bearish, plus three commodity plays including two flight-to-safety/inflation insurance precious metal funds. Our BRIC ETFs overall were down—as one would expect in a -12% market: India (IFN, -3%), China (FXI, -6%), and Brazil (EWZ, -15%); plus the emerging markets-oriented US Technology ETF (IWY) tracked the market (-11%, which BTW did edge out the NASDAQ for the quarter by one point, for those keeping score at home). Our repurchase of the precious metal EFTs looks good so far with GLD +13% and SLV +10%; the agriculture commodities ETF (DBA) held its own (-1%). Our UltraShort Lehman 20+Year Treasury ETF (TBT), which goes up when the value of long-term treasuries decline, as they tend to do when long-term interest rates rise, had a disastrous quarter (-27%), as the European sovereign debt crisis sparked a flight-to-safety run on US government bonds, and interest rates consequently plummeted. Some of those losses were offset by profits on the purchase and sale of the three index short ETFs for the DOW (DOG), NASDAQ (PSQ), and S&P 500 (SH) during the quarter; we purchased them again towards the end of the quarter and were slightly ahead. We also made a profit on our sale of the Malaysia ETF (EWM), although the sale price was a tad lower than the close at the end of last quarter.

Overall, we are now 48 points ahead of the market in terms of total return-on-investment: +21% for us and -27% for the S&P 500 in the three-and-a-half years since the inception of the IMSIP at the end of 2006. We are one point ahead of our benchmark, the GAI Global Macro Hedge Fund Index, +21% to +20%. In terms of compounded annual growth rate, after three years IMSIP is +6%, the GAI hedgies are at +5%, and the S&P 500 is -10%.

Analysis: After five straight quarters of declining volatility, things got interesting—as in, “may you live in interesting times”—in 2Q10. A combination of continued slower-than-expected economic growth and the specter of sovereign debt defaults among European countries combined to spook the markets big time. The potential threat of defaults by any of the PIIGS (Portugual-Ireland-Italy-Greece-Spain) is considered to be extremely serious because it could engender a cascade of bank collapses—all over Europe and beyond—similar to the danger in 2008 attendant to a collapse of AIG, Bear Stearns, Citibank, Freddie, Fannie, Merrill Lynch, and/or Wachovia (all of whom were eventually bailed out by the US government). The powers-that-be most definitely consider that this would be a catastrophic eventuality, to be avoided at all costs. Thus the likelihood that central banks will once again deploy taxpayer dollars to bailout the moneyed elites, this time for their fecklessness in loaning money to over-extended governments instead of for their foolishness being lured into ludicrous spectulative bets by Goldman Sachs and their ilk.

Our perspective is that this is yet another swerve in the extended oscillating skid which we have written of before. The combination of intrinsically short-sighted democratically elected—and, more to the point, re-elected—politicians and a culture that increasingly craves instant gratification has done us in. We got into this situation by overspending, borrowing beyond our means, and speculating on bubble-valued assets. The U. S. government’s attempts to address our problems have generally been short on addressing systemic issues and long on creating the temporary illusion that things are getting better.

The proper way to defeat an oscillating skid is to turn into it, thus affording your tires traction and enabling you to regain control. In our case, we could do this by allowing the insolvent financial institutions to go out of business, as they so richly deserve to. We could require more stringent capital requirements for both lenders and borrowers doing business in the USA. We could clean house at the regulatory agencies so they will actually enforce the rules already on the books (e.g., not allowing naked short selling). We could make it illegal for ratings agencies to accept payment from any company they rate. We could create an exchange for the trading of derivatives. We could encourage good corporate governance practices (e.g., favoring for government contracts companies that reward management with long-term stock options rather than instant cash bonuses so that corporate leaders’ interests were better aligned with the long-term interest of shareholders). We could reduce social welfare spending commitments to sustainable levels going forward.

But instead, we are fighting the skid at every turn. We are throwing good taxpayer money after bad propping up the “too big to fail” banks. We are debasing our currency in futile attempts to reinflate the housing and credit bubbles that got us into this latest fix in the first place. Instead of addressing the systemic problem of overcommitted government largesse, we are expanding the role of government and increasing our commitments.

Conclusion: There is no such thing as a free lunch. Someone always pays, sooner or later. For decades, we—through our elected leadership—have relentlessly whipped out our national credit card to, in effect, pass the debt on to future suckers. Well, if you have a mirror handy, you can meet one of those future suckers right now. The government is still flashing plastic, but now it is a debit card, and the account being charged is the one that’s comprised of your life savings.

In our best effort to avoid those charges, as of 1 July, we continue to hold four long emerging market ETFs in the portfolio: China (FXI), India (IFN), Brasil (EWX), and US high tech (IYW which we consider an emerging market play as some two-thirds of the revenue of the companies comprising the ETF are ex-USA derived). We believe that in a deleveraging environment, the economies that are still growing will fare far better than those that are not; thus these long positions will be the last we will surrender if and when things get really dicey. Already, things are somewhat dicey…enough so that we now have four inverse ETFs (that go up when whatever they are tied to goes down) to serve as insurance against a sudden worsening of the sovereign debt crisis (which could be either European- or domestic state/local government-based): the short DOW index ETF (DOG), the short NASDAQ index ETF (PSQ), the short S&P 500 index ETF (SH), and the inverse long-term Treasury bonds ETF (TBT). We are considering unloading this last because the (up-to-now) European sovereign debt crisis has engendered a perverse flight-to-safety that is driving U.S. bond rates down (and the values of the bonds up), even though in the long run the USA is no more solvent than Greece. We believe the value of those bonds will eventually plummet but we have held TBT for over a year now with no joy and it could be we can do better with the funds between now and a more opportune time to be short treasuries.

We also still have three long commodity plays: the agriculture ETF (DBA) and precious metals ETFs for gold (GLD) and silver (SLV). The dollar actually stronger again last quarter, the flight-to-safety reaction to the European sovereign debt crisis resulted in increased gold and silver prices anyway. In the longer run, we expect another massive round of central bank quantitative easing in response to the next crisis—or the one after that—and in the deluge of dollars that results, the commodities positions should provide some dry shelter for our assets.

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2009 inclusively) provides a CAGR of around 14.0%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.3%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance.

Transactions: We had another quiet quarter, with only a couple of sales:

Performance Review: An indifferent quarter for IMSIP, as we were down 1%, while the S&P 500 was up 5% and the macro hedge funds up 2%.Tactically, despite our deep skepticism about the validity of the continued strong market rally, we remain mildly bullish here. Our emerging market ETFs overall were slightly up: Malaysia (EWM, +10%), India (IFN, +2%), and China (FXI, flat), and Brazil (EWZ, -1%). As mentioned previously, we sold our gold and silver commodity ETFs—prematurely in the event, as both ended the quarter higher than they were 9 Feb when we sold—but our remaining commodity play, agriculture, was down (DBA, -8%). The US Technology ETF (IYW) was up 1% for us; if it continues to lag the NASDAQ index—which was up 4% in the quarter—we will likely trade it in. Our one short position, the UltraShort Lehman 20+Year Treasury ETF (TBT), which goes up when the value of long-term treasuries decline, as they tend to do when long-term interest rates rise, was down 2% and rates remained stubbornly low during the quarter despite torrents of fresh debt offerings by the U.S. Treasury.

Overall, we are now 44 points ahead of the market in terms of total return-on-investment: +26% for us and -18% for the S&P 500 in the three years and three months since the inception of the IMSIP at the end of 2006. We are seven points ahead of our benchmark, the GAI Global Macro Hedge Fund Index, +26% to +19%. In terms of compounded annual growth rate, after three years IMSIP is +7%, the GAI hedgies are at +6%, and the S&P 500 is -6%.

Analysis: The market doggedly continues to accentuate the positive, up yet another 5% in the quarter, while volatility—a good fear indicator, which set a new all-time high in 4Q08—declined for the fifth straight quarter, actually reaching the historical average. While the U.S. unemployment rate remained unchanged at 9.7% in March—which was good compared to the steady increases in 2009—there was actually job growth (+162,000 non-farm jobs). Corporate profits were strong again in 1Q10 and consumer spending—evidently powered by the Energizer bunny—somehow continues to outstrip gains in personal income month-after-month:“Personal income increased $1.2 billion, or less than 0.1 percent, and…[p]ersonal consumption expenditures (PCE) increased $34.7 billion, or 0.3 percent,” in February, according to the latest Bureau of Economic Analysis data. Inflation and interest rates (except for credit card debt) remain low, and the stock market has now recovered 75% since the March 2009 low (S&P 500 666.79 on 6 Mar 09).

As we continue to point out, we got into this situation by overspending, borrowing beyond our means, and speculating on bubble-valued assets. In previous reports, we have lamented that the U. S. government’s attempts to solve our problems have generally made things worse, whilst creating the temporary illusion that things are getting better. We recently came across a presentation by Dylan Ratigan of MSNBC that does a good job illuminating this sad situation, which Mr. Ratigan ascribes to evil intent (presented below in two parts):

We expect there are some bad actors but in general, it is our belief that most of what has happened is due to ignorance and unintended consequences. Mr. Ratigan is spot on in lamenting that most members of Congress have no clue how our financial system functions…but in that lack, they well reflect the populace at large. Our political leaders surely intended well, for example, when they mandated that mortgage loans be made available to folks who previously did not qualify back in 1999, and the Fed fed the housing bubble in the 2000s by keeping interest rates low. Get more folks owning their own homes, stimulate the economy, what’s not to like? But the resulting poisonous stew of insidious incentives for everyone involved to act in their own short-term best interests—inveigling folks to overpay for properties they couldn’t afford in the first place with the expectation that with prices sure to keep rising, they could sell to the greater fool for a profit—then packaging the resultant mortgage-backed securities, mislabeling them a high-grade with the connivance of the ratings agencies and selling them to credible financial institutions, etcetera, etcetera. Just about everyone behaved short-sightedly with little if any regard for systemic risk; there is plenty of blame to go around.

Where we do agree with Mr. Ratigan is with respect to his criticism of what is happening—or, in some cases, not happening—now: the continued attempt to reflate values back up to tulip bulb mania levels, the continued assumption of the debts of so-called “too-big-to-fail” institutions by the government, the failure to pass meaningful reforms such as sundering the cozy relationship between ratings agencies and the institutions who create the equities to be rated—as insane as this sounds, currently the former are paid by the latter—and creating an exchange for credit default swaps and other esoteric financial instruments to ensure transparency and facilitate the self-governing influence of market forces—not to mention creating a mechanism for dismantling big failed financial institutions in an orderly way and holding their leadership personally accountable for their failures which would better align their interests with that of the owners and society as a whole.

For that matter, why are we bailing these failed institutions out by assuming their debts? And why are we undertaking additional obligations such as health care and dubious stimulus programs on top of the existing deficits plus the imminent demographic-driven shortfalls in entitlements funding? Why are we focused on heath insurance and cap-and-trade when the real threat to our way of life is our failure to understand and address our financial failings?

Conclusion: Sadly but surely, we remain confident that the worst is yet to come. However, we cheerfully admit we have no idea when. Perception is reality, and so long as the market perceives that things are hunky dory—as it manifestly does now—it is a greater risk to capital to fight it (go short) than to go with the flow.

Accordingly, as of 1 April, we continue to hold five long emerging market ETFs in the portfolio: China (FXI), India (IFN), Brasil (EWX), Malaysia (EWM), and US high tech (IYW which we consider an emerging market play as some two-thirds of the revenue of the companies comprising the ETF are ex-USA derived). Most of these would go—and be replaced by inverse index ETFs (that go up when the market goes down) if and when things get dicey again.

We also still have one long commodity play and a short on treasuries as hedges against the decline of the dollar: the agriculture ETF (DBA) and the inverse long-term Treasury bonds ETF (TBT). The dollar actually was stronger last quarter, and we sold our gold and silver ETFs in anticipation that a flight-to-safety reaction to the European sovereign debt crisis would buttress it even more, and deflate commodity prices. That did not happen and we are not likely to remain so unhedged against a dollar decline for a lengthy period because the longer we sit on a bench in the station, the greater that chance that train will leave without us.

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2009 inclusively) provides a CAGR of around 14.0%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.3%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance.

Transactions: We had an uncharacteristically quiet quarter, with only some year-end coupon clipping to break the monotony.

21 Dec – FXI dividend of $0.222/shr

22 Dec – EWM dividend of $0.142/shr

23 Dec – IYW dividend of $0.052/shr

29 Dec – EWZ dividend of $0.111/shr

For the year overall, there were 16 buy and sell transactions, compared with 13 in 2008 and 15 in 2007.

Performance Review: A strong quarter for IMSIP, as we were up 6%, narrowly beating out the S&P 500 (up 5%) and whupping the macro hedge funds (flat). For 2009 overall, we were +20%, which trailed the +23% performance of the S&P 500 but came in far ahead of the hedgies (+9%).

Tactically, with the market strong again this quarter and the dollar weak, we let our emerging market and commodity long positions ride. Every single position was up in the quarter, including our one remaining short position, the UltraShort Lehman 20+Year Treasury ETF (TBT, +13%), which goes up when the value of long-term treasuries decline, as they tend to do when long-term interest rates rise. Also boosted by the weaker dollar, our commodity ETFs all advanced in price during 4Q09: gold (GLD +9%), agriculture (DBA, +3%), and silver (SLV, +1%). The emerging market ETFs also did well: Brazil (EWZ, +14%), Malaysia (EWM, +6%), India (IFN, +5%), and China (FXI, +4%). Finally, our economic recovery hedge, the US Technology ETF (IYW) was up 11% for us; despite it’s name, the ETF has considerable offshore exposure as many of the US companies the fund invests in have material revenues and profits outside the USA.

Overall, we are now 48 points ahead of the market in terms of total return-on-investment: +27% for us and -21% for the S&P 500 in the three years since the inception of the IMSIP at the end of 2006. We are nine points ahead of our benchmark, the GAI Global Macro Hedge Fund Index, +27% to +18%. In terms of compounded annual growth rate, after three years IMSIP is +8%, the GAI hedgies are at +5%, and the S&P 500 is -8%.

Analysis: The naked emperor is still marching grandly down main street, and the populace appear to see nothing amiss—at least not the S&P 500, who applauded to the tune of +5% in 4Q09, as volatility edged down closer yet to normal. What’s not to like? The increase in unemployment has slowed if not ceased, corporate profits have been strong and sales may be edging up again with inventories extremely lean, inflation and interest rates (except for credit card debt) remain low, and the stock market has recovered 60% since the March 2009 lows.

As we have said before, we got into this situation by overspending, borrowing beyond our means, and speculating on bubble-valued assets. In point of fact, the emperor is a very sick man—you will recall that scary visit to the emergency room in late 2008—and marching him around in the dead of winter with no clothes on does not rate up there with the smartest of moves the USA has made.

Speaking of late 2008, nearly every time he makes a speech about the economy, Barack Obama makes it a point to blame the previous administration for the mess “we inherited.” That’s good politics 101, most definitely—and W was indeed a disaster—but blaming him for wrecking the economy is a dangerous exaggeration. The economy was already on the brink of breakdown due to decades of short-term thinking and bad management by both government (deficit spending, neglect of the dollar, refusal to deal with structural issues such as entitlements and energy, nurturing of bubbles) and business (failure of manufacturing industries to innovate and adapt, failure of finance industry to manage risk). The economy was already desperately ill; W took us on a walk in the freezing rain with no coat and so we ended up in the emergency room.

Unfortunately, the current administration actually do appear to believe their own rhetoric—they genuinely do blame W for making us sick in the first place, rather than just facilitating a breakdown. As a logical extension of that thinking, the Obama administration are—just as W did at the end, ironically—pumping us full of decongestants and painkillers (loose money and low interest rates) in a frantic attempt to get us to feel better. LOL they are even consulting the same “doctors” (Bernenke, Geithner, and a cabal of Goldman Sachs graduates). They are treating a serious disease as if it were a bad cold. Plus, they are so clueless that they are making things worse by committing us to huge new entitlements and subsidies (e.g., health care and so-called “green” energy). Like the freezing emperor’s storied new clothes, these programs sound great in theory but with no money to fund them, there’s no there there.

This is why it is dangerous to blame W. Unless and until we recognize that we have long-term structural issues and begin to seriously address them, whether or not inflating the dollar, cash-for-clunkers, artificially low interest rates et al lure the stock market higher and make us feel better, the underlying health of our economy will continue to deteriorate.

Until, that is, it totally collapses. Because if we keep treating symptoms and ignoring the disease, we ain’t seen nuthin yet.

And speaking of symptoms, another big blip on the radar screen as 2010 ensues is the quality of sovereign debt. Not just the USA, that is. The bankruptcy of Iceland’s banks in late 2008 and the narrowly averted collapses in Greece and Dubai in late 2009 have exacerbated concerns that defaults on national debt are increasingly likely. Check out this WSJ interview with Harvard economics professor Ken Rogoff about how sovereign defaults may play out, and also this list of sovereign debts ranked as a percentage of annual gross domestic product. And while we’re on the subject of Prof. Rogoff, here is an article about his study concluding that (surprize!) high levels of debt as a percentage of GDP are strongly associated with slow-to-no economic growth. Specifically, growth drops off a cliff at around a 60% ratio of debt-to-GDP—where the USA is now—and pretty much disappears entirely around an 80% ratio or higher.

When you look at Japan, for example—not that Japan is on anyone’s list of countries in imminent danger of default—and see public debt that exceeds GDP by 70%, you have to scratch your head and wonder how they get out of that box. Up to now, the Japanese have been able to finance their debt at very favorable terms internally—over 90% of it, in contrast to the USA (we depend much more on foreign borrowers, including Japan). But Japan has virtually no immigration, and a falling birthrate; consequently, their citizens are, on average, getting older. Retirees are more likely to be selling government bonds than buying them. And there are relatively fewer younger workers to take up the slack. Of course, once Japan is constrained to go to the world markets to refinance their debt, they will presumably have to pay higher (market) interest rates…and we already know that a debt-to-GDP percentage of 170% is not conducive to economic growth so raising revenue to make ends meet is unlikely to serve.

Conclusion: While we are confident the stroll of the naked emporer will not end well, we have no earthly idea how far he will get before [a] everyone realizes his new clothes are a sham or [b] he collapses from exposure…or even which is more likely to happen first. We can say that so long as this parade of unbridled optimism ensues, it is a greater risk to capital to fight it (go short) than to go with the flow.

Accordingly, as of 1 January, we continue to hold five long emerging market ETFs in the portfolio: China (FXI), India (IFN), Brasil (EWX), Malaysia (EWM), and US high tech (IYW which we consider an emerging market play as some two-thirds of the revenue of the companies comprising the ETF are ex-USA derived). Most of these would go—and be replaced by inverse index ETFs (that go up when the market goes down) if and when things get dicey again.

We also still have three long commodity plays which are hedges against the decline of the dollar: gold (GLD), silver (SLV), and agriculture (DBA)…these are more likely to stay in the portfolio, although one risk we are concerned about is a short term “flight-to-safety” dollar rally in the event of an exogenous macro event such as Spain defaulting on their debt or Israel attacking Iran’s nuclear facilities. Such a development could also adversely affect our short long-term Treasury bonds ETF (TBT), at least in the short run.

So while we have made no changes in the lineup recently, we are prepared to make significant changes any time now. Well, actually, any time, period.

Position = security the portfolio owns
Bought = date position acquired
Shares = number of shares the portfolio owns
Paid = price per share when purchased
Cost = total paid (price per share multiplied by # shrs plus commission)
Now = price per share as of date of report
Value = what it is worth as of the date of report (price per share multiplied by # shrs plus value of dividends)
Change = on a percentage basis, change since last report (not applicable for positions new since last report)
YTD (Year-to-Date) = on a percentage basis, change since the previous year-end price
ROI (Return-on-Investment) = on a percentage basis, the performance of this security since purchase
CAGR (Compounded Annual Growth Rate) = annualized ROI for this position since purchase (to help compare apples to apples)

Notes: The benchmark for the Intelledgement Macro Strategy Investment Portfolio (IMSIP) is the Greenwich Alternative Investments Global Macro Hedge Fund Index, which historically (1988 to 2008 inclusively) provides a CAGR of around 14.3%. For comparison’s sake, we also show the S&P 500 index, which since January 1950 has produced a CAGR of around 7.2%. Note that for our portfolio’s positions, dividends are added back into the value of the pertinent security and not included in the “cash” total (this gives a more complete picture of the ROI for dividend-paying securities). Also, the “Cost” figures include a standard $8 commission and there is a 1% rate of interest on the listed cash balance.

Performance Review: Another adequate quarter for us, as we were up 2%, and now +13% YTD. For the second consecutive quarter we were beaten out by both the macro hedgies—who were up 3%—and by the S&P 500—who recorded a second consecutive great +15% quarter. YTD, the S&P 500 is up 17%, we are up 13%, and the hedgies are up 9%.

Tactically, with the market moving inexorably northwards, we unloaded three of our last four short positions early this quarter—only our short on 20+ year treasury bonds remains—and added three long ETFs (Malaysia, Brasil, and high tech).

Overall, we are now 45 points ahead of the market in terms of total return-on-investment: +20% for us and -25% for the S&P 500 in the 33 months since the inception of the IMSIP at the end of 2006. In terms of compounded annual growth rate, we are edging out the GAI Global Macro Hedge Fund Index over the same time spans, +7% to +6%.

Analysis: The conventional wisdom now is that we suffered a sharp recession in 2007-09, but it is now over and the main question is how sharp and fast the recovery will be. Accordingly, the market in 3Q09 was less volatile and continued to move up dramatically. Two consecutive quarters of +15% ROI is pretty impressive; in an average year, the S&P 500 index is ±16%, so we have had two years worth of movement in the last six months. (Volatility has remained low because the pace of the increase has been steady and—from day-to-day—moderately paced, with no big corrections.)

As we have said before, we got into this situation by overspending, borrowing beyond our means, and speculating on bubble-valued assets. And the policies the Bush administration implemented—and the Obama administration has continued—of attempting to paper over the cracks in the system with bailouts of bad banks, bad real estate loans, bad credit default swaps, and bad industrial companies are neither the morally correct thing to do nor in our own long-term self interest. To the extent these actions succeed in postponing our day of reckoning, they ultimately succeed primarily in digging us into a deeper hole.

However, it is clear that the massive tidal wave of liquidity that the central banks—especially the Fed—have loosed on the world has succeeded in buying a significant stay of execution, albeit at the cost of alarmingly increasing the rate of decline in the value of the dollar. Accordingly, we are (as always) long commodities and also long emerging market plays, as we agree with the market perception that those economies will fare better than ours in the near- and medium-term future, although we still anticipate a significant economic disruption that will interrupt their growth…at which point we plan to have our capital elsewhere.

But for now, the sun is shining, so we are making hay. Being short here would, we expect, prove out to be the right stance in the medium term, but right now, we believe the opportunity for long gains outweighs the risk of not being able to shift gears quickly enough when the market turns.

Conclusion: We still believe things will almost certainly get worse…but given the prevalent bullish psychology, we don’t expect the market to perceive the serious problems we see for at least three-to-six months, and possibly up to 24 months with a lot of luck. (Whether it would be good luck or bad for the true nature of our problems not to become evident for another two years is left to the reader to consider as a useful thought exercise.) As of 1 October, we have five long emerging market ETFs in the portfolio: China (FXI), India (IFN), Brasil (EWX), Malaysia (EWM), and US high tech (IYW which we consider an emerging market play as some two-thirds of the revenue of the companies comprising the ETF are ex-USA derived). We have three long commodity plays which are hedges against the decline of the dollar: gold (GLD), silver (SLV), and agriculture (DBA). And we remain short long-term Treasury bonds ETF (TBT), as we expect 20+ year treasure bonds to decline in value as interest rates inevitably rise in order to entice buyers of the copious outpourings of US debt. We have enough cash to undertake two more positions and currently are considering shorting the dollar and a “buy-what-China-needs” play such as going long energy or Canada or Australia.

Finally, the spectre of systemic risk still lurks, and while we do not anticipate it will surface unbidden in the near future, a disruptive macro event (e.g., an Israeli attack on Iran’s nuclear facilities) could roil the waters at any time. Consequently we remain prepared to reconfigure the IMSIP to be more congruent with our medium-term macro analysis.